A widespread myth is that 90 to 95 percent of new restaurants fail. In 2007, H.G. Parsa, a Professor of Hospitality Management, researched the statistic, and reports that the real failure rate is 60 percent -- about average for new businesses. Nevertheless, 60 percent is still high. Because restaurants have generally low profit margins, it's important that fixed costs, including rent, do not exceed sustainable margins.

A Rough Guide

Writing in Forbes, Maureen Farrell estimates that for the entire restaurant industry, rent averages about 8 percent of gross sales. Other restaurant consultants give estimates ranging from 5 to 10 percent. The feasibility of a given rental percentage will be different for different restaurant types and for different locations. Restaurant profit margins are lower than for most small businesses. Farrell estimates that margin as five percent, while the National Restaurant Association cites it as eight percent. This makes keeping track of fixed costs important. A rental percentage much higher than the average needs to be justified by other aspects of the particular restaurant's financials.

Rent As a Percentage of Profits

One way to tell if a projected rental cost makes sense is to take into account the restaurant's profits. While many restaurants have low profit margins, a few have profit margins of 19 percent or more. For example, say you have small bistro with a busy bar in an upscale, high-traffic area. It grosses $700,000 annually and its gross profits are $140,000. Even if the rent is 20 percent of gross sales, which is about twice the average, the restaurant would still be unusually profitable. The rent may be not only sustainable, but a bargain.

Relative Efficiency of Rental Costs

The two biggest fixed restaurant costs by far are food and labor. Food costs, according to DLoewi Consulting, range from 26 to 36 percent of gross sales, and labor costs range from 30 to 40 percent. Note that labor costs are not immediately responsive to sales volume -- a busy restaurant's labor costs may not be much higher than another restaurant's with half its tables empty. An increase in rental costs of 5 percent of gross sales -- from, say, 6 percent to 11 percent -- represents nearly a doubling of rental costs, but if it increases gross sales by an additional 10 percent, the result may be a substantial rise in profitability. While food costs will probably rise in step with sales volume, labor costs may rise only slightly.

Higher Is Better

An HVS Global Hospitality Services article notes that a full-service restaurant grossing under $1 million to $1.5 million annually will have a difficult time maintaining profitability because, as sales volume decreases, labor costs tend to go down more slowly. For this reason, a restaurant located in a venue that generates less than the recommended $1-1.5 million minimum requires a rental cost that is below the average of 5 to10 percent of gross sales. The author notes that charging more than this, even from the landlord's perspective, isn't good business, because the restaurant may not survive.

About the Author

Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.